Sean Cornett - Director of IR Sam Mitchell - CEO Mary Meixelsperger - CFO.

Simeon Gutman - Morgan Stanley Faiza Alwy - Deutsche Bank Jason English - Goldman Sachs Christopher Bottiglieri - Wolfe Research Olivia Tong - Bank of America Merrill Lynch Stephanie Benjamin - SunTrust Christopher Shaw - Monness, Crespi, Hardt Nick Cecero - Jefferies & Company.

Good morning. My name is Marianna, and I will be your conference operator today. At this time, I would like to welcome everyone to Valvoline's 4Q 2018 Earnings Conference Call and Webcast. All lines have been placed on mute, to prevent on background noise. [Operator Instructions] Thank you.

I would now like to turn the call over to Sean Cornett, Director of Investor Relations. You may begin your conference..

Thanks, Mariama. Good morning, and welcome to Valvoline's Fourth Quarter Fiscal 2018 Conference Call and Webcast. Valvoline released results for the quarter ended September 30, 2018, at approximately 5:00 p.m.

Eastern time yesterday, November 5 and this presentation and remarks should be viewed in conjunction with that earnings release, a copy of which is available on our investor relations website at investors.valvoline.com. These results are preliminary until we file our Form 10-K with the Securities and Exchange Commission.

A copy of the news release has been furnished to the SEC on a Form 8-K. With me on the call today are Valvoline's Chief Executive Officer, Sam Mitchell; and Mary Meixelsperger, Chief Financial Officer. As shown on slide 2, any of our remarks today that are not statements of historical fact are forward-looking statements.

These forward-looking statements are based on current assumptions as of the date of this presentation and are subject to certain risks and uncertainties that may cause actual results to differ materially from such statements. Valvoline assumes no obligation to update any forward-looking statements.

In this presentation and in our remarks, we will be discussing our results on an adjusted basis, unless otherwise noted. Adjusted results exclude key items which are unusual, nonoperational or restructuring in nature. We believe this approach enhances the understanding of our ongoing business.

A reconciliation of our adjusted results to amounts reported under GAAP and a discussion of management's use of non-GAAP measures was included in our earnings release. The non-GAAP information provided is used by our management it may not be comparable to similar measures used by other companies.

Now as we turn to slide 3, I'll turn things over to Mary and to review our financial results for the quarter and the fiscal year..

Thanks, Sean. For the fiscal fourth quarter, Valvoline delivered reported operating income of $105 million, net income of $45 million and EPS of $0.23. For the full year, Valvoline delivered reported operating income of $395 million, net income of $166 million and EPS of $0.84. Fiscal 2018 cash flow from operating activities was $320 million.

As mentioned in previous quarterly earnings calls, Valvoline early adopted new accounting guidance in the first fiscal quarter of 2018 that reclassified non-service pension and OPEB income as non-operating.

As a result, our adjusted EBITDA and adjusted EPS now exclude pension and OPEB income and expense, and prior periods have been revised to conform to this presentation. In the fourth quarter of both fiscal 2017 and 2018, key items were primarily pension related.

This quarter, non-service pension and OPEB income was offset by mark-to-market remeasurements, netting to $20 million of after-tax expense. In the prior year quarter, key items totaled $48 million of after-tax net income. For the fiscal 2018, the largest key item was related to U.S.

and Kentucky tax reform, increasing our reported tax expense by $78 million. Expenses related to legacy and separation items, along with acquisitions and divestitures, netted to $10 million after tax. Pension and OPEB income and related remeasurements offset for no net impact for the full year.

Now as we move to slide 4, I'll review our adjusted results. Adjusted EBITDA grew 9% to $121 million in Q4 and grew 4% for the year to a new record of $466 million. This growth was driven by exceptional performance in Quick Lubes and solid growth in International. Adjusted EPS for the quarter grew 21% and grew 9% for the full year.

Full year free cash flow grew 16% to $227 million due primarily to the benefits of lower cash taxes. We continued to deliver against our goal of returning cash to shareholders through share repurchases and dividends totaling $114 million in Q4 and $383 million in fiscal 2018.

Let's turn to slide 5, which summarizes our financial results for the quarter and the year. Sales were up 9% on volume growth of 2% in Q4. For the year, sales grew 10% and volume was up 1%. Almost 40% of the growth in 2018 sales is attributable to pricing actions, reflecting our success of passing-through raw material cost increases.

Adjusted EBITDA increased 9% to $121 million in Q4, driven by favorable volume mix and acquisition benefits. For the year, adjusted EBITDA grew 4%, also driven by favorable volume mix and acquisitions as well as $3 million of foreign exchange benefit and higher equity and other income, which were partially offset by planned increases in SG&A.

In Q4, adjusted EPS grew 21% to $0.34, and grew 9% to $1.29 for the year. A lower effective tax rate, a lower share count and higher adjusted EBITDA offset higher interest costs, leading to the year-over-year growth in EPS for both periods. Let's move to slide 6 to discuss key corporate items.

Net interest and other financing expense was $18 million in the quarter and $63 million for the year compared to $14 million and $42 million in the prior year periods, respectively.

The increase is primarily driven by higher borrowings, which was largely attributable to the pension borrowed upon transactions that we executed during the fourth quarter of fiscal 2017.

In Q4, we successfully executed another bulk lump-sum transaction, reducing pension plan assets and liabilities by approximately $130 million and further lowering overall pension risk and volatility. Our reported effective tax rate for the quarter was 21.1%. Adjusted for key items, our effective tax rate was 26.1%.

For the year, our adjusted effective rate was 27.2%. 2018 cash flow from operating activities was $320 million, up $56 million after adjusting for the voluntary pension funding last year primarily due to lower cash taxes. Full year capital expenditures were $93 million, and free cash flow was $227 million.

Net debt was flat to last quarter at $1.2 billion. We continued returning cash to shareholders in the quarter, repurchasing $101 million in Valvoline stock and paying a dividend of $13 million. For the year, we repurchased $325 million of Valvoline stock and have paid $58 million in dividends, returning a total of $383 million to shareholders.

Now let's turn to the next slide and look at our fiscal 2019 outlook. We anticipate volume to grow between 2.5% and 3.5% and sales to grow 7% to 9%. Beginning in fiscal 2019, Valvoline will adapt the new revenue recognition accounting standard. The impact of the new standard is primarily a reclassification of certain items within the income statement.

We anticipate the approximate impact of these reclassifications to increase sales by $45 million, increase cost of goods sold by $55 million and decrease SG&A by $10 million. We expect continued strong same-store sales performance with Quick Lubes, growing 6% to 7%.

We also anticipate new unit additions, exclusive of any acquisitions, of 27 to 32 company stores, including 6 stores from fiscal 2018 that shifted into fiscal '19 due to hurricane-related construction delays. As of today, 4 of these 6 have now opened.

In addition to the 31 franchised stores that we acquired last week, we expect 30 to 40 new franchised stores as the pace of growth among our franchisees remain strong. We will continue to make SG&A investments to drive growth primarily in sales, advertising and marketing for Quick Lubes and International.

Overall, SG&A is expected to increase between 6% and 8%. We expect adjusted EBITDA to be in the range of $480 million to $495 million, increasing low single to mid-single digits. Adjusted EPS is expected to increase mid-single to low double digits in the range of $1.35 to $1.43.

We anticipate only modest impacts from tariffs, as we primarily utilize local manufacturing. Based on current rates, we expect a $5 million to $6 million FX headwind. Our EPS guidance doesn't assume any additional share repurchases in fiscal 2019. We will assess additional repurchases in May 2019 or thereafter.

Capital expenditures are expected to be between $115 million to $120 million, an increase driven by the planned China plant investment. Free cash flow is forecast to be in the range of $190 million to $210 million. Now let me turn it over to Sam to discuss more of the segment results and outlook, beginning on the next slide..

Thanks, Mary. I'd like to review our segment results in a little more detail. Core North America continued to increase its premium branded mix, but the segment faced a competitive environment that became more challenging in the second half of the year and for most of the year faced a significant increase in raw material costs.

Quick Lubes had another strong quarter and exceeded our expectations for the year. 2018 marks the first time that we've added a significant number of ground-up company stores.

These additions, along with the larger franchised system acquisition we completed last October as well as the continued unit growth on the franchise aside, drove exceptional growth in sales and adjusted EBITDA. In International, volumes were up 2% for the year.

Adjusted EBITDA grew 12%, driven by joint venture contributions, unit margin expansion and favorable foreign exchange benefits. Let's take a look at the next slide to discuss the benefits of our multichannel model. Since the IPO, we have experienced significant raw material cost inflation, with base oil prices increasing about 30%.

However, our multichannel model has generated relatively stable unit margins over this time, which are provides Valvoline's total gross profit per gallon compared to base oil prices per gallon over the last 2 years. As you can see, despite base oil prices increasing during this period, our total unit margin has in fact increased.

Our Core North America's unit margins did decline during the second half of 2018, which I'll address in a minute. However, growth in the International and Quick Lubes segments more than offset these declines. The point is our business model has produced profitable, steady growth even during periods of significant raw material inflation.

Now let's review more on 2018 and the outlook for 2019 in each segment, starting on the next slide. Let me briefly review Core North America's main channels to market by looking at a breakdown of volume. The retail channel has 2 main components. The first is made up of sales to auto parts retailers and mass merchandisers.

These are primarily Valvoline-branded lubricants sold to DIY consumers. The second is lower-margin non-branded packaged goods sold to warehouse distributors, for resale to small DIFM garages, which make up roughly a third of the volume.

Sales through the installer channel are primarily a mix of branded lubricants and non-lubricant specialty products sold to DIFM outlets, including national and regional accounts, and also include the growing volumes sold to heavy-duty fleets. Core North America's results in 2018 were below our expectations, driven by 2 main factors.

First was branded DIY volume which was lower than we expected due primarily to an increase in competitive promotional activity. This began in Q3, continued in Q4 and remains elevated today.

The second issue was the pricing environment in the installer channel, which was very competitive this year primarily driven by the disruption of multiple raw material cost increases.

Installer channel volume also decreased in 2018, but this was mainly due to declines in one of our large national accounts that recently filed for bankruptcy and the transfer of Great Canadian Oil Change sales to Quick Lubes. There are three factors driving lower forecasted unit margins in 2019.

First, the accounting changes for revenue recognition and the transfer of Great Canadian Oil Change sales to the Quick Lubes segment account for a decline of $0.15 to $0.17. Second factor is due to business mix with moderately lower DIY-branded volume and continued growth of lower-margin heavy-duty volume.

The third is the continued impact of installer channel pricing pressure. We are now forecasting Core North America's unit margins in the range of $3.60 to $3.70. Let's take a look at some of the actions we're taking to improve Core North America's performance on the next slide.

While we don't expect a significant rebound in DIY volume, our 2019 merchandising and advertising will feature the right mix of offers and compelling consumer messaging, which we believe will effectively drive sales.

In installer channels, our teams are focused on executing value-added initiatives that are expected to improve business results for our customers. These initiatives include digital marketing programs to drive traffic, training on selling value-added products and services and incentives to increase penetration of our broader product portfolio.

Our heavy duty market share is relatively small, but our volume is growing double digits. This is an opportunity that requires little incremental investment, so we plan to continue to pursue it aggressively. In addition, we're focused on cost efficiency from top to bottom to maintain a strong margin profile.

In summary, we believe we are taking the necessary actions to enable the business to remain a strong cash generator. We'll shift gears to Quick Lubes on the next slide. Our industry-leading quick lube business had another successful quarter in Q4.

Same-store sales across the Valvoline Instant Oil Change system were up 7.6% versus prior year, with company-owned stores increasing 6.9% and franchised stores growing 8.1%.

For the year, system-wide same-store sales were up 8.3%, marking our 12th straight year of same-store sales growth and the first time that average sales per store passed $1 million. Average store sales have grown at nearly 6% over the last 10 years. These are remarkable achievements that demonstrate the strength of the business that we've built.

Our same-store sales increase resulted from a balanced contribution from strong transaction and average ticket growth due to our marketing and customer retention programs, excellent in-store execution as well as pricing and premium mix benefits. We expect our same-store sales momentum to continue in 2019, growing 6% to 7%.

Sales and EBITDA growth also benefited from higher store count both from acquired and new stores. 2018 was the first year that we added significantly new ground-up company stores and also our first international expansion with the acquisition of the 73 Great Canadian Oil Change stores.

We're increasing our retail presence in Canada to more than 100 stores with the closing of the Oil Changers acquisition announced last week. In 2019, we expect to continue to add company and franchised stores at a healthy pace while pursuing additional acquisition opportunities. We'll also continue our focus on talent management.

We've been proactive in adjusting wage rates to address local market conditions. I'm pleased with the team's ability to fill our stores with high-level talent in a tight labor market. Let's turn to the next slide. Profitability was strong in our International business in 2018.

Adjusted EBITDA grew 12% and increased 9% excluding the benefits of foreign currency exchange. Despite modest volume growth, solid EBITDA growth was driven by our ability to manage costs and successfully pass-through raw material inflation.

2018 volume growth slowed primarily due to the loss of a sizable low-margin account in Southeast Asia and our business model change in Brazil. Our strong partnership with Cummins continues to drive results, especially in emerging markets like India and China.

Initiatives like the differentiated heavy-duty motor oil product we launched last year in China helped drive volume growth in emerging markets to 7% in fiscal '18, including JV. In 2019, we anticipate volume growth to be more in line with our longer-term expectations of high single-digit increases.

We'll continue to invest in our teams and in building our brand to help drive future growth. Given the projected FX headwinds, overall EBITDA growth next year isn't planned to be as strong as this past year, but we are building a base for continued improvements going forward.

Valvoline has developed profitable businesses in each of the major regions around the world. The global transportation lubricant market outside of North America is nearly 5 billion gallons. This market is extremely fragmented, with the top 5 players commanding only 38%.

The overall market is growing slightly, as the effect of economic growth is offset by longer drain intervals. However, as emerging markets move more rapidly toward higher fuel and emission standards, demand is shifting toward more technically capable products, representing an opportunity for Valvoline.

With only a few exceptions, our market share is modest internationally, however, we've been successful growing that share using a consistent formula; growing channels to market, building brand awareness, developing superior products and services and leveraging relationships with key OEMs like Cummins.

Before we move to Q&A, I would like to take a few minutes to highlight why we remain bullish on the opportunities ahead of us and how we plan to drive shareholder value. Slide 16 shows how we've allocated our operating cash flow in the form of CapEx, M&A, dividends and share repurchases over the past 3 years.

In Core North America, our primary focus has been to sustain its strong, steady cash generation. We've made significant organic and inorganic investments primarily in Quick Lubes but also in International. We returned excess cash to shareholders in the form of dividends and share repurchases consistent with our target.

This powerful business model generates strong cash flow, and our priorities are to allocate this capital to high-return investments. Let's take a closer look at Core North America's cash generation on the next slide. The profile of the core North American business is one of strong EBITDA margins combined with low capital intensity.

This combination drives strong cash generation. In fact, over the last 3 years, Core North America has generated more than $0.5 billion in EBITDA, less CapEx, an impressive amount.

We've used this cash primarily to invest in our growing Quick Lubes business, both on new company store growth and acquisitions; as well as other projects with returns typically in the mid-teens.

Going forward, our focus is on cost management to maintain strong margins and selective investments to sustain a stable Core North America business that generates the cash we need to fund the future growth of the company. Let's now look at this capital allocation in more detail on the next slide.

We've proven that Quick Lubes is a business where Valvoline is a best-in-class operator. You can see that our same-store sales growth over the past several years has well exceeded that of automotive aftermarket peers and exceeded the organic growth of most of our mid-cap consumer peers.

As I noted earlier, our sales have now grown to more than $1 million per unit, nearly 40% higher than the U.S. industry average as reported by National Oil & Lube News. Investing in new company-owned stores is expected to generate high returns.

We forecast new stores to generate roughly $350,000 of run rate EBITDA at the end of year 3, benefiting from the unique vertical integration of the business. In other words, the new ground-up stores that we opened in 2018 are anticipated to have a significant impact on our results in just a few years.

Valvoline today, in combination with our franchise system, has a national footprint with plans in place to drive store growth. The market potential from a store perspective is still large, as most of the U.S. and Canada is made up of a highly fragmented base. Valvoline is already a leader in both markets, but there is opportunity for further growth.

Our scale and sophistication provide us with a significant competitive advantage. Our strong cash flow provides capital to grow our market share through acquisition and organic growth. Let's look at the last slide that shows where our investment in Quick Lubes is expected to lead.

Our approach to grow our quick lube business is anticipated to drive significant changes to our segment mix of adjusted EBITDA over time. Since 2016, the Quick Lubes contribution to our EBITDA mix has increased from 30% to 40%. Our store count has increased by almost 175 units in that time.

As we continue to grow and add stores over the next 5 years, we expect that Quick Lubes could generate approximately 50% of our EBITDA mix. While International's growth will be strong, its relative profit contribution is expected to stay in line with where it is today at approximately 20% of our EBITDA mix.

Core North America will remain important in funding our growth but is expected to be a smaller part of our total EBITDA. We also forecast that our total EBITDA will grow because the fastest-growing component is the segment with the highest margin.

The resiliency of the business model and predictability of our results should also improve with the growth of our retail service business. Continued execution of our strategy and core priorities is anticipated to drive growth for Valvoline and value for our shareholders. With that, I'll turn it over to Sean to open the line for Q&A..

Thanks, Sam. [Operator Instructions] Mariama, please open the line..

Your first question comes from the line of Simeon Gutman with Morgan Stanley. Your line is open..

Good morning everyone. My first question relates to Core North America. Within the guidance for the 2.5% to 3.5% gallon growth, can you - is volume growth implied? Or what is volume growth implied? And then in general, should we expect an inflection in that business in gallons? Or sort of flat could be the new normal for it..

Yes, overall for the company, the volume growth that we're expecting is going to be driven by the quick lube business and the International business. Our expectations for Core North America growth are very modest.

In fact, we're projecting relatively flat volume in 2019, and that is reflecting the continuation of the competitive environment that we're seeing in both the DIY retail segment and the installer segment..

And Sam, I would actually dig on that a little bit and say we did have some business model changes that we mentioned while we were talking about the business that occurred in the fourth quarter of 2018 with the move of our GCOC business over to Quick Lubes as well as some other changes related to Express Care.

And those changes will reflect about a 1-million-gallon decline in the Core North America business in '19. So there will be a modest decline in 2019 as a result of that business model adjustment..

Okay. And then my follow-up. Sam, you mentioned some competitiveness in the do it yourself for the retail and then in the installer channel. Can you maybe give us some historical perspective? Because the company, sort of short history, is a public company.

Has the environment always been that competitive? You'll recall a time where you've cited this continued intensity. And then is it unusual, and that's what I'm trying to build to. What's your expectation for that going forward? Are there unusual actions by competitors? That's it..

As I shared in the last quarter, we saw a good amount of promotion activity at each - at a number of the retail accounts and that elevated activity is - we're expecting that to continue into 2019, and we're building our plans around that.

And so as we look at 2019, we're just taking a bit more of a defensive posture in terms of the progress that we expect to make during the fiscal year ahead..

Okay, thanks Sam and Mary and good luck next year..

Thanks Simeon..

Your next question comes from Faiza Alwy with Deutsche Bank. Your line is open..

Yes, hi, good morning. So I wanted to touch on 2 things. I guess first is if you could just talk about like your same-store sales outlook for next year. And I know you've said 6% to 7%. So if you could disaggregate how much of that is maybe market share gains versus how much the category overall is growing.

And then I know, Sam, you touched upon just the market is very fragmented, but maybe if you could give us an update on how big do you think the quick lube - like the number of stores you could have within the quick lube segment until you reach saturation..

Yes. First, regarding the performance of the business and how much is share gain related. So we're seeing some really good balance in our overall same-store sales performance both in driving customer counts and in driving higher ticket. So it's a pretty good mix between both in 2018 and what we expect in 2019.

So the overall category, as far as quick lube performance, doesn't appear to be growing. So when we look at the industry data provided by National Oil & Lube News, our competitors have not been improving their share. And so our - we're a bit of an outlier with the performance that we continue to achieve with that business.

We think we've built a much stronger business model than our competitors with more sophisticated marketing; and in particular better execution in our stores, getting that consistent execution across the whole system, company stores, franchised stores. It's great to see the franchisees performing as well as they are.

So our expectation is we'll continue to take market share in 2019 and actually for many years ahead because of the advantages that we've built in this business. And so that will happen both through continued customer count growth.

And then it will happen, of course, as we add new stores into the - into our base both in company markets and in our franchise markets. We've really mapped out an aggressive plan for continued store growth for our franchisees that have signed franchise development agreements. They're committed to add another 240 stores over the next 6-year period.

And then on the company-owned front, of course, we're making some good progress and having built our capabilities to add roughly 25 stores per year.

And we continue to invest in those capabilities, would like to see that grow into the future, but our guidance for next year reflects again another 25-plus stores that we'll add in 2019 and then continuing to aggressively pursue acquisition. And I think there's a long runway for us to add stores with - when we look at North America being U.S.

and Canada. With the acquisition that we've made in Canada, we now have a footprint of 1,270 stores, roughly. And we're seeing this continued opportunity for store growth.

So at this point, we're going to continue to lean into that hard and continue to execute on our plan to drive company store growth, franchised store growth; and continue to pursue acquisitions..

Okay. And then I just wanted to follow up on just your outlook for base oil prices from here, especially in context of the consumer having a negative reaction to the price increases.

Like does your guidance assume sort of further base oil price increases, or do you assume some relief in that?.

So, we're projecting a relatively stable market into 2019, and that is a relatively new development from just a month or so ago when it looked like we were more in an inflationary environment. So it does appear that the inflationary environment is calming down, and as a result, we're projecting for more stable base oils.

And that's good news for our business. It enables us to execute the plans with our customers both on the retail and on the installer side. That brings real value both to the customer and to the consumer..

Thank you very much..

Your next question comes from Jason English with Goldman Sachs. Your line is open..

Hey, good morning folks. I want to come back to North America.

Sam, as we think about that pie chart you showed in terms of DIY and the independent DIFMs that you serve, is it fair to say the volume for that overall pie from an industry perspective is down sort of low single digits?.

Yes. On the DIY side, we've seen a decline right around 3% this year. That's fairly consistent with the long-term trends that we've seen in DIY of being down minus 2% to minus 3%.

And based on data that we have with the accounts that we've sold directly on the installer side of the business, I believe that side of the business is probably down 1% roughly in category demand. And that's also fairly consistent with what we see in the marketplace, our long-term projections of flat to down 1%..

Yes.

All that leaves me kind of confused when you talk about the drivers of weakness in Core North America and the action plan to address it going forward because I keep hear you - hearing you reference volume and share and your action plan going forward seems to be focused on addressing just that, volume and share, but your volume is outperforming the market and you have unit economics issue.

Your profit per gallon is falling well short of your expectations. Why - help me understand the motivation of chasing more volume and share rather than giving up some volume and trying to fix the economics issue..

Yes. First of all, it's a twofold attack that we're taking on it. And we want to be very cost effective in how we go after it, but we don't want to lose profitable volume. It's important for us to protect that volume and the share that we have in DIY, and we think we have good plans in place to grow it over time.

And in DIY right now, with some of the promotional pressures that we're seeing, we just - what we're saying is we've got to adjust our promotional schedules and make sure we're hitting the key price points. And we can do that without having a negative impact on those margins.

In DIY, we have been successful executing our price increases and defending those margins in a very successful way in the last couple years. And so we've just got to make sure that our merchandising and our consumer marketing is right on point to make sure that the DIY business stays a very healthy business for years to come.

And so that's really our focus. On the installer side of the business, we, certainly we've seen a lot of price pressure in this environment, where we've taken a number of price increases over the last couple of years.

And again, we're adjusting our plans appropriately there too not to chase unprofitable business but small adjustments really on the margin expectation.

And I want to go back to Page 10 to make sure that we're on track with the unit margin outlook for 2019 because, historically, we've talked about $4 as being that stable margin where we've been for the last few years. And so in taking that down, there's a couple of factors to consider.

One is the accounting changes that we've referenced with revenue recognition; and also the business model change where we did move some of the accounts over to the quick lube side of the business, Great Canadian being the largest portion of that.

That is accounting for roughly half or slightly more than half of the decrease, say, from the $3.95, $4 range, having an impact of, call it, $0.15 to $0.17 just from purely an accounting change.

So the real margin compression that we're seeing in 2019 is kind of in that $0.14 to $0.15 range based on the price pressure that we've seen on the installer side of the business.

So what we want to do is make sure that we're staying competitive and then building those margins back up with the - all the opportunities that we have on the installer business as we sell a broader portfolio of products into these customers.

So when you add it up, what we're saying is we're not expecting a big bounce back in Core North America in 2019, but we're not expecting further deterioration either. We're going to take somewhat a defensive posture into 2019 to make sure that we've got the plans in place to keep this business healthy over the long term.

I haven't changed my expectations for the long term on Core North America.

I still believe it's a business that can deliver modest improvements over time, but the key focus for us is going to be to make sure that we're, you've got a good, solid foundation both in the DIY business and also on the installer side and seeing good growth on the heavy-duty side of the business..

Help me understand how over time you build those margins back up with installer. Isn't that a lower-margin vertical for you? I think I heard you reference earlier sort of the mix degradation associated with growing there..

The installer business is a lower margin - lower-unit-margin business than DIY, but it still offers excellent return to the company. And over time, those margins improve with the premiumization of that business, so as there's shift to more synthetic mix on motor oils but also as we sell a broader portfolio there.

This is a big part of our digital initiative too and e-commerce initiative where we're working with the accounts to drive penetration of our coolants, filters, wipers, chemical products. We referenced new product innovation on the GDI front, GDI fuel system services being very well received by the installer side of the business.

So in addition to the lubricant GP, we're also adding additional GP on a per-account basis. So that's what keeps the installer business healthy and growing over time. Where we have referenced mix degradation is primarily with the heavy duty business.

The heavy duty business is a lubricants-driven business and carries a little bit lower margin, but it's a lower-SG&A opportunity. It's not a big investment business, but it's a business that now represents - it's going to be approaching 20% of our overall core North American business.

And we've seen consistent double-digit growth in that business, so we're going to become more of a major player there and taking advantage of great product capabilities And the relationship that we have with Cummins has really helped us in gaining momentum on this side of the business..

Okay, thanks a lot guys..

Your next question comes from Chris Bottiglieri with Wolfe Research. Your line is open..

Hi, thanks for taking the questions. Wanted to follow up a little bit on the lower guidance for North America. You called out a few items, like accounting change and the account loss.

Did either of those items impacted Q4 gross profit per gallon in North America?.

Yes, let me handle it and Mary, you can add to it as necessary, but Q4 certainly did come in lower than expectations. And there's a couple factors there in that, one, that the pricing in DIY was not realized as early in the quarter as we had expected. And so that benefited us and was fully executed towards the end of Q4.

So we'll see an improvement in core North American margins into Q1 because of that impact, but we didn't have that benefit that we had expected from DIY pricing in Q4. Some of the margin compression that we've referenced on the installer side of the business was impacting us in Q4 too.

And so when we look at our Q4 results versus expectations, about two-thirds of that shortfall had to do with the DIY pricing and the installer pricing pressure. And then about a third was primarily due to mix, with DIY-branded volumes being relatively soft versus expectation. So those were the key factors.

The business mix, we started to see that in Q4, where the Great Canadian Oil Change was made early in the quarter. And so that business mix impact did take effect in Q4, which impacted overall profitability for Core North America in Q4..

Got you, okay. And then I have a question on your 2023 outlook. So currently North American volume sounds structurally flat to negative at industry level, and the GPs are currently probably cyclical and maybe secular issues as well.

Over this 5-year period, are you assuming that North American EBITDA grows? Or can you give us a sense of the growth rates you're assuming to get to those contribution mixes in your 5-year outlook?.

Yes. As we develop this model, the expectations on Core North America are very modest. In fact, this will be in a low single-digit range for overall profit growth year-over-year. I do hope we can do better than that, but it does reflect a conservative outlook for Core North America.

And then for the quick lube business, it reflects the continued growth in same-store sales performance and the store growth additions and as I laid out in the presentation, we're expecting to see that momentum to continue and even accelerate as some of the new stores that are just coming out of the ground now will begin to impact profitability in a positive way in 2020 and beyond - go ahead..

Sorry. Just would you ever spin off the Quick Lubes business just given what - it seems like a pretty attractive asset? Does the autonomous branding or the distribution infrastructure prevent you from doing that? Just curious if there's a better way to monetize this pretty strong asset..

Yes. Today's presentation and what we've been communicating all along since the IPO, and we'll continue to emphasize it going forward, is the great business that we've built with the quick lube business and the opportunities that we have for growth.

So we're not seeing the growth slowdown at all with continued momentum both in organic performance within the store.

The move towards a greater convenience and strong execution in our stores allows us to drive the customer counts and drive the ticket and then that just drives the business economics when it comes to both new store growth, building new stores and acquiring stores.

So what we're saying today and reiterating is that this is a business that needs to be recognized for what it's bringing to the overall portfolio at Valvoline because it is one where we control all aspects from the product to the end customer, our competitors are relatively weak, and we will continue to benefit from their weakness.

And as this business grows, it tends to be the most predictable and consistent profit contributor even in an inflationary environment. The key for us too is that - and makes this business so strong is the vertical integration with our products.

And so this adds both to the company store profitability because of the products that are fed through our business model but also through our franchised stores. The profitability of our franchise business continues to be strong because it's both royalty and it - and then it's product profitability which is actually a multiple of the royalty.

So for us, we're always looking at our business and ways in which we can optimize the valuation of our business for our shareholders, but we see that there are very strong synergies between our core businesses and Valvoline Instant Oil Change, that they work in concert to drive faster growth for us.

Key for us, when you look at that last page, is that Valvoline Instant Oil Change and the Quick Lubes business will be our number 1 profit contributor in the short term here as we look even at 2019. And then when you look beyond into 2023, it becomes a very significant part of this overall business model.

So again, we're going to constantly look at ways in which we drive value for shareholders.

The key that we're sharing today is that we're going to make sure Core North America is a strong, stable business; and that when you take a look at the opportunities that we have in Quick Lubes and the International business, this is a business that can generate growth while generating strong cash flow..

Okay, thank you. Appreciate it..

Your next question comes from the line of Olivia Tong. Your line is open..

Thank you, good morning. Wanted to follow up a little bit on the outlook for Quick Lubes because same-store sales outlook is still quite strong and a bit ahead of the growth rate that you expected as you started fiscal '18. So can you talk through some of the main items that give you confidence a higher level is more sustainable than prior years.

And given the shares that you've taken already, how do you think about competitive response from - particularly from your largest competitor? They've obviously had quite a bit of share loss at this point, so why wouldn't they also up their spending to try and paddle back? And how would you be able to [indiscernible]? Thank you..

Yes, the drivers behind our share gains are continued effectiveness in our marketing programs. We continue to gain new insights; and delivering the right message at the right time, digitally delivered to our customer base around our stores.

So as we started to increase spending, going back over a year now, in our advertising programs, we've seen an outstanding ROI on those investments. The messaging is about service you can see, experts you can trust and the transparency of the business when you stay in your car.

We've even added cameras that now allow the consumer to stay in their car and see the work being done below the car, above the bar and this helps drive consumer preference for Valvoline because of how we build trust with them. Building trust with them drives stronger loyalty and repeat, and we're seeing that in our customer satisfaction scores.

And as we do that, that gives us the ability to sell additional services that we offer today in our stores that can drive overall ticket performance. And one of the ways in which we do that is continuing to invest in our team and the tools that they have to better explain our services to our customer and execute those efficiently with speed in mind.

So we have initiatives in place in 2019 that, one, continue to increase spending in advertising that will drive that strong car count; and then initiatives in our store execution plans and delivering that customer service that can continue to boost ticket as we better penetrate some of the additional services that we offer.

As far as the competitive response goes, some of our competitors are not set up to deliver on that same customer experience, whether it's staying in their car or how they train and equip their teams.

This is something that we've been investing in from our technology, our point-of-sale system, to how we train and retain our employees and give them the tools, the process tools, that allow us that consistent execution. It's not easy to do, and that's why our competitors struggle with that. We're going to benefit.

Another reason why we're so bullish on continued share growth is that we know that some of the competing stores that we have in existing markets are getting down to break-even levels of car counts. And so I think we'll see store closures because of the pressure that we're putting on our counts with such a big gap in the execution with the customer.

So obviously, we're not expecting to slow down at all, but we're - expect to continue to grow share among the quick lube category..

Got it. And then Mary, you had mentioned in your prepared remarks that you would - it's unlikely that you would, say, grant share repurchases until May of next year.

So is there, what would - what could potentially mute, move you off that target [ph]?.

Olivia, could you ask that again? I didn't catch the last part of it..

Sure. It was around the share repurchase, that you had said that it's unlikely that you would do anything before May of 2019. So just if you could give a little bit more color around that target and what could potentially move you one way or the other from that..

So we're really waiting until the 2-year anniversary of the full separation from our former parent company before we would make an evaluation to go back into the share repurchase market. We're just being sensitive about separation-related risks. And so we're waiting until that full 2-year mark before we would reassess on the share repurchase.

Having said that, we are still very bullish in reinvestment related to our capital spend, new stores and on the acquisition pipeline within the quick lube business, so our focus between now and then will continue to be in that area.

And we've also said in the past that we'd like our dividend rate to be more consistent with our CPG peers and we will be reevaluating the dividend here at our upcoming board meetings..

Great, thank you..

Your next question comes from Stephanie Benjamin with SunTrust. Your line is open..

Hi, good morning. I just wanted to kind of speak here a little bit of the reduced operating expenses during the quarter and just kind of what those levers were.

I think SG&A came in below my expectations and just kind of looking at it year-over-year, so I just wanted to know what was kind of done operationally in the fourth quarter to drive that improvement. Thank you..

Hi, Stephanie, this is Mary. Yes, in the fourth quarter, we saw some favorability as a result of certain reductions in certain incentive compensation accruals as well as reductions in some advertising and consumer promotion in line with some of the lower volumes that we saw within the Core North America business.

Those two items were a significant portion of the SG&A decline. We also had some true-ups in our benefit account areas, which is really related to the timing of primarily around the employee medical benefit, just some favorable experience..

Got it, all right. Thanks so much..

Your next question comes from Mike Harrison with Seaport Global Securities. Your line is open..

Unidentified Analyst:.

So what are the drivers? Is that mostly increased spending in the Quick Lubes or International? Or just what kind of is moving this a little higher?.

Sure. The increase is primarily driven - about 50% of the increase - after taking into account the accounting adjustment, about 50% of the increase is related to advertising, marketing and direct sales expense within the quick lube and International markets.

About 25% of the increase is related to the reinstatement of those incentive compensation expenses that we reduced in 2018. About 15% is related to quick lube acquisitions, and the balance is just kind of broad inflation within - primarily within payroll and merit inflation..

All right.

And then in Core North America, thinking about SG&A, are there any levers you guys can pull to sort of reduce some of the operational costs in that segment in a lower growth environment?.

Yes, definitely. We're going through a process of taking a hard look at our SG&A, making sure every dollar spent is working hard for us in bringing value to our customers. And so it's a combination of both direct and indirect, our corporate spend.

It's taking a hard look at our plant-related costs and our indirect costs on the plant operations side too. So we're taking a hard look at it. We think there's opportunity there that's going to help us manage through the current environment that we're in.

So our goal overall is to be very efficient and focused on the cost structures in Core North America while focusing on those initiatives and innovations that can bring real value to both installer customers and to the DIY customers and consumers. So I think we've got a good plan, the right initiatives and focus going into fiscal '19.

Like I said earlier, we're just taking a relatively defensive posture around '19, not expecting a big bounce back, but I do think we're taking actions to make sure that the business stays healthy for the long term..

All right, thank you..

Your next session comes from Laurence Alexander with Jefferies. Your line is open..

Yes, hi this is Nick Cecero on for Laurence. So I guess switching gears is that I wonder if you could provide some color on your International segment and maybe what you're seeing across the different regions as there've been concerns over China and Europe..

Yes, we're seeing a lot of opportunity for improvement to International and to continue to grow the business. We've got very good momentum in places like China, India and Latin America.

Certainly, we're keeping an eye on developments in China, if the overall market slows somewhat, but again for us it's more about leveraging our capabilities and our brand to drive share growth and better penetration in the markets, particularly as they step up to more premium-performing lubricants.

An example in China, and I referenced it earlier in the presentation, is a new heavy-duty engine oil that we developed, co-developed, with Cummins that resulted in very significant growth for us in 2018 in the heavy duty market.

Well, that specification that, that new engine was meeting based on tighter emissions controls, that continues to grow into '19 and '20 as the new emission standard for all new engines begins to take hold in places like China and India.

So the opportunity for us with our superior-performing heavy-duty lubricants and leveraging the relationship with Cummins is quite significant in both China and India. We've had excellent success growing our business with Cummins in other parts of the world too where we don't have joint ventures.

Mexico is a really good example of that, and also our work in developing a new natural gas engine platform that replaces diesel in certain markets for the marine transportation industry. So we're seeing a lot of opportunity for continued growth in our International businesses. Again, we've continued that momentum in India, China, Southeast Asia.

We've added 4 new distributors in 2018. The - so we're bullish on the International business, and we'll continue to invest in building those capabilities both in sales and marketing and on the supply chain side..

Great, thank you very much..

You're welcome..

Your next question comes from Chris Shaw with Monness, Crespi. Your line is open..

Hey good morning, how're you doing. I wanted to just ask specifically about the EBITDA guide. I mean it looks like it's 3% to 6% growth. And given what the sort of revenue outlooks you've kind of given for quick lube and International and even factoring in, I guess, the sort of increase in SG&A, I guess I'm having a hard time getting to the 3% to 6%.

It doesn't seem like you're getting much leverage on that sales growth in the two big businesses. And Core North America, is it just expected that EBITDA is going to be down significantly in 2019? I'm trying to just do the math, and I guess I can't get to exactly where you guys are.

Can you give, provide a little more color there?.

Yes. I mean the guidance reflects what we're saying is that Core North America profit growth is going to be nominal. I mean we're looking at relatively flat performance there, and that reflects just some of the challenges that we're seeing in both the DIY retail and installer segments. So we're going to make sure that we don't take a step back.

We are working hard to make sure that we're being as cost effective as we can in that business, and I think that's the right plan for us. So the EBITDA guidance is impacted, the lower growth is impacted by that Core North America business not growing as we would typically expect it to.

However, on the quick lube front and on the International front, quick lube business obviously is going to show significant profit growth in 2019. The International business, as we noted, is going to - profit growth is muted by the negative FX impact that we're expecting based on the current foreign exchange rates.

So that's how you're getting to that guidance..

So, and Chris, the primary thing I'd point to you is the $5 million to $6 million of headwind in the International business from the FX headwind that we're facing primarily in China, Australia and India, where we're seeing some substantial local currency challenges going into '19..

Okay.

And then is there any - in the EBITDA guidance, is there any impact from the accounting changes? Or is that apples to apples?.

The bottom line impact is relatively small. It might be a very modest less than $1 million of a negative impact overall, but we're - it's really primarily just a geography thing within the P&L..

And was the - I'm sorry. I forget the name of the second Canadian acquisition you did, but is that - were they also customers? And so will the actual revenue impact initially not be significant.

Will it just transfer from Core North America to Quick Lubes as well?.

They were not customers. So that's incremental business to us as the - as Valvoline becomes the oil used in those 31 stores. So that's a very strong acquisition for us. And again, it's in the eastern side Ontario. It gives us a base in Ontario and Iowa [ph]. So we're excited to make that acquisition, giving us a really strong footprint across Canada..

It's net new volume for the Quick Lubes business there..

Core North America, do you expect to regain any of the base oil increase this year, or is that not projected?.

We don't guide for that. We're basically assuming pretty well stable base oil environment from where the poster prices are today. So to the extent that we see some improvements in base oils, we could see in fact some tailwind benefits from that, that aren't currently reflected in our guidance..

All right, thank you..

There are no further questions at this time. I will now turn the call back over to the presenters..

Thanks, everyone, for joining our call this morning. And we'll talk to you again soon..

Thank you..

This concludes today's conference call. You may now disconnect..